By the Numbers
The GNPL market warms up before The Main Event
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
BlackRock’s recent auction of a $420 million portfolio of Ginnie Mae project loan pools looks like an early test of the market ahead of an expected $12 billion auction of project loan REMICs in June. Relatively strong results on the smaller portfolio, owned by UBS through its acquisition of Credit Suisse, may portend well for the larger portfolio, owned by the FDIC after the collapse of Signature Bank. On the one hand, the UBS loans look likely to prepay faster than the loans backing the FDIC portfolio through the negative refi incentives likely to prevail in coming years. On the other hand, the buyer base for pools is quite small and typically limited to dealers trying to structure REMICs while the buyer base for the FDIC REMICs should include dealers, real money and leveraged investors.
Although BlackRock only releases auction results to buyers, anecdotal reports suggest most of the UBS portfolio traded well. BlackRock offered the loans in three groups: loans largely originated in 2020, largely originated in 2021 and largely originated in 2022. The 2020 and 2021 groups traded while 2022 did not. The earlier vintages had more property appreciation, which tends to raise prepayment speeds, and consequently may have attracted stronger bids.
Profile of the UBS portfolio
GNPL pools generally trade to dealers trying to package them into REMICs instead of end accounts, as their very low liquidity and long final maturity tends to leave most investors without a viable exit strategy.
The UBS portfolio was 100% construction loans and has a higher weighted average coupon, which means it is likely to prepay faster over time across all refi incentives.
Profile of the $420 million portfolio of UBS Ginnie Mae project loans that are 100% construction loans:
- Construction loan issue dates between September 2020 and June 2022 (blue circles in Exhibit 1).
- Note rates between 2.50% and 3.00% with a weighted average note rate of 2.85%. This is higher than the $12 billion FDIC portfolio from a similar timeframe, in part because the FDIC portfolio is primarily project loans.
- On average, these construction loans are about 200 bp out-of-the-money to refinance based on current spreads between project loan commitment (PLC) rates and 10-year Treasury rates, which is still lingering wide. The spread as of April based on available data is 126 bp between PLC rates and 10-year Treasuries. During normal times, prior to the pandemic, that spread averages 90 to 100 bp. A normalization of the spread will lower PLC rates by 25 bp, increasing refinance incentives (or decreasing the disincentive) across the board.
- Construction loan rates are higher than regular project loan commitment rates (red line) due to the greater risk of transitional properties. Once the loan converts it typically has a higher refi incentive, all else being equal, because the rates tend to be higher and the equity in the property has increased.
Exhibit 1: Construction loan rates of CS portfolio in market context
Note: Project loan commitment rates are weighted average monthly rates based on origination date. The CS loan note rates are as of the issuance date.
Source: BlackRock, Bloomberg, Santander US Capital Markets
Based on the higher rates and greater amount of equity, converted construction loans have historically prepaid much faster than project loans when there is a positive refinance incentive. Historically they have also tended to prepay slightly slower by about 1 CPR to 2 CPR when the refi incentive is flat to negative (Exhibit 2).
Exhibit 2: Historical GNPL s-curves
Source: Ginnie Mae, Santander US Capital Markets
Since the beginning of 2020, converted construction loans are now almost uniformly prepaying faster than project loans, even when the incentive to refinance is negative (Exhibit 3).
Exhibit 3: Recent GNPL s-curves
Note: The very deep out-of-the-money prepayment speeds (-300 bp or more) for construction loans post-2020 have smaller balances behind them, so may not be representative.
Source: Ginnie Mae, Santander US Capital Markets
It’s possible that borrowers with construction loans made in 2020 or later are using the additional equity gain to flip the property, whereas the borrowers with regular project loans are longer-term investors. If so, these higher CL prepay speeds may persist for the next few years even at flat to negative refinance incentives.
Profile of the FDIC portfolio
A detailed overview of the FDIC portfolio is in Shopping a $14 billion portfolio. Of the $14 billion portfolio, the $11.6 billion anticipated in June is comprised of GNPL securities issued in 2020 to 2021:
- The weighted average interest coupon on the securities is 1.68% and the weighted average mortgage coupon of the underlying collateral is 2.77%.
- At 15 CPJ the projected weighted average life is 4.4 years, but of course that’s not what anyone expects. A more reasonable model is anywhere from 2 to 7 CPJ, which would result in a WAL of 13 to 8 years.
- Over the past 3 months the prepayment speed for the portfolio has averaged 1.3 CPR, but since issuance the CPR has been 4.5.
- In addition to the current interest payment of 1.68%, the current principal payment is 2.55%, bringing the total monthly payment to 4.23%.
- Construction loans in GNPL deals tend to average 10% to 30% of the collateral, compared to 100% in the CS portfolio.
Lower liquidity of pools
GNPL pools generally trade to dealers structuring REMICs instead of end accounts, as their very low liquidity and long final maturity tends to leave most investors without a viable exit strategy. On the upside, the pools still have the prepayment penalties attached since there hasn’t been any structuring. The GNPL securities in the FDIC portfolio are all long duration, last cash flow, principal and interest classes which don’t receive prepayment penalties.
Assuming the primary buyers of the UBS pools were dealers, they will likely use to the pools to mix in to future GNPL deals to diversify the collateral, either lowering or raising the WAC as desired, or perhaps tailoring the interest only class to suit a particular investor need.
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